Page 65 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes
Example: A US investor who buys a German stock denominated in marks (German
currency), must ultimately convert the returns from this stock back to dollars. If the
exchange rate has moved against the investor, losses from these exchange rate
movements can partially or totally negate the original return earned. Obviously,
US investors who invest only in US stocks on US markets do not face this risk, but in
today's global environment where investors increasingly consider alternatives from
other countries, this factor has become important. Currency risk affects international
mutual funds, global mutual funds, closed-end single country funds, American
Depository Receipts, foreign stocks, and foreign bonds.
(b) Country Risk: Country risk, also referred to as political risk, is an important risk for
investors today. With more investors investing internationally, both directly and
indirectly, the political and therefore economic stability and viability of a country's
economy need to be considered. The United States has the lowest country risk, and
other countries can be judged on a relative basis using the United States as a
benchmark. Examples of countries that needed careful monitoring in the 1990s because
of country risk included the former Soviet Union and Yugoslavia, China, Hong
Kong, and South Africa.
11. Liquidity Risk: Liquidity risk is the risk associated with the particular secondary market
in which a security trades. An investment that can be bought or sold quickly and without
significant price concession is considered liquid. There is more uncertainty about the time
element and the price concession, the greater the liquidity risk. A treasury bill has little or
no liquidity risk, whereas a small OTC stock may have substantial liquidity risk.
Liquid Assets Risk: It is that portion of an asset's total variability of return which results
from price discounts given or sales concessions paid in order to sell the asset without
delay. Perfectly liquid assets are highly marketable and suffer no liquidation costs. Illiquid
assets are not readily marketable and suffer no liquidation costs. Either price discounts
must be given or sales commissions must be paid, or the seller must incur both the costs,
in order to find a new investor for an illiquid asset. The more illiquid the asset is, the
larger the price discounts or the commissions that must be paid to dispose of the assets.
12. Political Risk: It arises from the exploitation of a politically weak group for the benefit of
a politically strong group, with the efforts of various groups to improve their relative
positions increasing the variability of return from the affected assets. Regardless of whether
the changes that cause political risk are sought by political or by economic interests, the
resulting variability of return is called political risk, if it is accomplished through legislative,
judicial or administrative branches of the government.
Domestic political risk arises from changes in environmental regulations, zoning
requirements, fees, licenses, and most frequently, taxes. Taxes could be both direct and
indirect. Some types of securities and certain categories of investors enjoy a privileged tax
status.
International political risk takes the form of expropriation of non-residents' assets, foreign
exchange controls that won't let foreign investors withdraw their funds, disadvantageous
tax and tariff treatments, requirements that non-residents investors give partial ownership
to local residents, and un-reimbursed destruction of foreign-owned assets by hostile
residents of the foreign country.
13. Industry Risk: An industry may be viewed as group of companies that compete with each
other to market a homogeneous product. Industry risk is that portion of an investment's
total variability of return caused by events that affect the products and firms that make up
an industry. For example, commodity prices going up or down will affect all the commodity
producers, though not equally.

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